U.S. Senate hears impact of fed tax reforms on territories

The impact of federal tax reforms on the insular areas was the subject of a U.S. Senate Committee on Finance hearing on Tuesday but there was no immediate information available from the committee about whether or not any of the territories submitted written testimony.

In addition to the impact on territories— American Samoa, Guam, Commonwealth of the Northern Mariana Islands, U.S. Virgin Islands and Puerto Rico— the hearing also examined the impact of federal tax reforms on Native American tribes.

In a statement distributed prior to the hearing, committee chairman U.S. Sen. Max Baucus (D-Montana) said, “Our desire to spur broad-based economic growth and give help to those who need it stays the same.”

He says federal tax laws have been constantly changing since 1986 and have created too much complexity and unfairness. “Tax reform needs to simplify the code in a way that creates jobs and encourages growth,” he said and noted “U.S. law is a patchwork of complicated rules for each territory.”

In the territories, federal tax law previously contained an economic activity tax credit and a possessions tax credit to encourage investment, and these credits expired at the end of 2005, he said.

Testifying specifically on the territories, was Dr. Steven Maguire of the Congressional Research Service, saying that the possibility of federal tax reform “will have an impact on the territories”, but the “magnitude of that impact will depend on the nature of federal reform and how the territories respond.”

He explained that federal tax reform would have an impact on the territories in two ways. Firstly, he said American Samoa, CNMI, Guam and USVI each mirror the U.S. federal tax code and as a result, when the U.S. tax code changes so does their tax code in these territories. He explained that Puerto Rico’s tax code is an independent tax regime, though it is modeled on the U.S. tax code.

(McGuire appeared to be unaware that the mirrored tax code that American Samoa follows is the U.S. tax code that was in effect on Dec. 31, 2000. The local legislature passed in early 2001 a retroactive amendment freezing the tax code at that date after ASG realized the territory did not have revenue to fund the ‘child tax credit’ that went into effect that tax year.)

Secondly McGuire explained, there are specific provisions in the U.S. tax code that directly benefit one or more of the territories and this group of provisions is often found in so-called “extenders” legislation, according to Maguire in his written testimony.

“The impact of United States tax reform on the territories would depend in large part on the specifics of U.S. tax reform and how the territories responded to the changes,” he said and pointed out that one option would be for the territories “to decouple from the mirror system.”

Maguire revealed that American Samoa, Guam, and CNMI each have pending negotiations with the U.S. about ending the mirror system and coordinating with the United States on a new territory tax system.

“This option would allow the territories to be largely unaffected by U.S. tax reform, unless they choose to enact similar reforms,” he said. “Alternatively, continuing with the mirror system the territories would incorporate the federal changes.”

If the changes focus on increasing the 'progressivity' of the federal tax code with higher rates for higher income earners, the impact on the territories would likely be muted as average income is significantly lower in the territories, he points out.

“In any case, this option would effectively cede control of the territories’ tax systems to the U.S,” he added.

For American Samoa, he said, the territory’s tax system mirrors the federal tax code. Technically, the American Samoa tax is a local tax and American Samoa residents are still responsible for U.S. taxes.

They file in both the U.S. and American Samoa, but all locally sourced income is excluded for purposes of U.S. income taxes, he said adding, that unlike the other territories, the American Samoa tax structure does not “replace” the U.S. federal tax.

“The American Samoa tax, however, is a territorial tax that is modeled after the U.S. federal tax,” he said.

He also noted that corporations in American Samoa calculate taxes for the American Samoa corporate tax just as U.S. corporations calculate taxes for U.S. corporate taxes and claim foreign tax credits for taxes paid to other countries, including the U.S.

The official also briefed the committee on the American Samoa economic development tax credit that could be impacted on any proposed tax reforms.

He said a domestic corporation is allowed a credit for operations in American Samoa to offset U.S. corporate tax liability, adding that the credit is limited to the amount of U.S. corporate tax liability generated by American Samoa sourced income.

The credit was intended to replace the expired possessions tax credit (or Section 936) and as such is limited by the tax code with language contained in the repealed sec. 936.

He said President Obama’s fiscal year 2013 budget proposes extending the credit retroactively through 2013. “The expected revenue impact of extending the proposal would be a reduction in federal revenues of $21 million over the three-year budget window of FY2012 through FY2014,” he said.

According to Maguire, the existing mirror structure seems to be a reasonable attempt at coordinating the tax regimes of the U.S. federal government and the territories. “Abandoning the mirror system would likely increase compliance and administrative costs for taxpayers with territory and U.S. sourced income,” he added.

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